October Fiscal Deficit Shoots to a New Record! Deficit-to-GDP ratio Swells in Good Times, What Happens on Bad Times?

"In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. ... This is the shabby secret of the welfare statists' tirades against gold. Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists' antagonism toward the gold standard—Alan Greenspan

In this issue

October Fiscal Deficit Shoots to a New Record! Deficit-to-GDP ratio Swells in Good Times, What Happens on Bad Times?

-Record Fiscal Deficit Equals Greater Government Control of the Economy and Rising Risks of a Fiscal Crisis

-How Does One Analyze Financially the Transition to a Neo-Socialist State? Credit Allocation Determined by Politics

-The Carrying Costs of Spend, Spend and Spend Elixir: Accelerating Credit and Sovereign Risk and Peso Devaluation

-The Contortion of Keynesian Economics: Bulging Deficit-to-GDP Ratio in Good Times; With Emergency Policies in Place, What’s Left When The Tide Runs Out?

October Fiscal Deficit Shoots to a New Record! Deficit-to-GDP ratio Swells in Good Times, What Happens on Bad Times?

Record Fiscal Deficit Equals Greater Government Control of the Economy and Rising Risk of a Fiscal Crisis

Figure 1

With 10-months through 2018, the National Government’s (NG) fiscal deficit zoomed to Php 483.1 billion as public spending outpaced collections immensely. The 10-month deficit has raced 25% above last year’s annual rate with two months to go! (figure 1 upper window)

Though revenues recovered to jump by 20.33% year-on-year from September’s 1.13%, public expenditure growth sizzled at 35.16% in October from 26% a month ago. As such, October deficit more than doubled (174%) at Php 59.87 billion from 2017’s Php 21.8 billion.

The Bureau of Internal Revenue (BIR) collection growth bounced 15.61% in October from the -7.68% it registered in September. It was, however, revenues from the Bureau of Customs (+30.38%) and Non-Tax Revenues (+31.97%) that provided the main boost for the total revenue growth in October. BIR, BoC and Non-tax revenues had a revenue share of 66.78%, 22.67% and 9.93% of the total.

Following its peak in late 2017, tax revenue growth has been decelerating in line with the slowdown in the growth of total bank loans. The bounce in tax revenues in October appears to have echoed the rebound in the bank loans (+18.36%) in the same month from 17.42% in September and 18.83% in August.

Figure 2

In the 10 months, 2018’s total collection growth of 17.53% was the second highest since 2011’s 17.88%. However, despite a broader tax base and substantial increases in excise taxes, BIR collection growth of 11.6% trailed marginally 2016’s 11.69%, and lagged widely 2014’s 18.84%, 2013’s 20.36%, 2012’s 11.99% and 2011’s 14.29%. 

Again, much of the growth in total revenues have been from collections by the BoC from the record imports that has brought about unprecedented trade deficits, and from non-tax revenues. And record imports have been much about public and private sector spending related to build, build and build. To this end, the government’s aggressive deficit spending produced a twin deficit: trade and fiscal deficit.

It is for this reason that TRAIN 2.0, from the perspective of the NG, must be onboarded.

NG collections would have to be kept at a targeted level to sustain the projected rate of fiscal deficit. Otherwise, a shortfall in total collections would unexpectedly widen the fiscal gap thereby requiring a disproportionate amount of funding.

And the risk of a fiscal crisis increases in the event of an unanticipated blowout in the spending-revenue gap.  “Fiscal crisis” is a term coined by James O'Connor who denoted of a “structural gap” between public revenues and expenditures that leads to an economic, social and political crisis (encyclopedia.com).

Though studies like the IMF observed the emergence of such crises based on plummeting growth and unemployment and or a surge in inflation; from my perspective, the financing the gap should be more of a concern.  Access to local savings through the banking system, domestic and international capital markets will play crucial roles in the bridge financing of the accretion of such deficits. 

The 10-month data tells us that the escalation in public spending rather than a shortfall of revenues has engendered such a historic deficit.

As such, the aggressive pace of public spending has resulted in the government’s direct share of the estimated 10-month GDP to surge to 20.18%, the highest ever since 1986. Such figures exclude indirect expenditures or private sector spending on public projects (such as Public-Private Partnerships or PPPs).

Such frenzied rate of public spending ventilated through unmatched deficits reveals of the structural shift in the growth model of the Philippine political economy.

The Philippines has rapidly been moving away from a market economy and has transitioned to a socialist (state) economy, patterned after China. The neo-Maoist model.

And since government spending means competition for resources and funding, the bigger the share of the government, the lesser resources and funds are made available to the private sector. And with a lesser output from the diversion of funding and resource consumption to the government, street prices can be expected to rise, as it has.

How Does One Analyze Financially the Transition to a Neo-Socialist State? Credit Allocation Determined by Politics

How does one model or analyze such a transition? The shift towards political directed economic activities would render financial ratios, like PE, Price to Sales, ROIC and etc., obsolete!

For instance, instead of business viability, the principal determinant of credit quality would be about political connections. 

Politically instituted monopolies would emerge as a result of business barriers and the political picking of winners and losers.

Legislative bills purportedly aimed to “open” the economic backdrop to a business-friendly environment would be all a sham for as long as the government continues to shanghai the economy’s resources and finances.

Moreover, sustained intrusion through various political channels such as regulations, mandates, licenses, prohibitions, taxation and more, cements the control of the economic sphere by politicians, bureaucrats and special interest groups.  

It’s like the alleged deregulation of the Telecom industry in 1995 (RA 7925) which ended up with an oligopolistic structure, primarily because of operational interventions. Yes, on the surface, the government deregulated the industry, but the stranglehold of the industry increased resulting in the elimination of competitors by operational interventions.

And the same politically determined operational obstacles have been used to displace alleged competition to usher in the entry of China Telecoms as the third player last month. Fitch Solutions wrote: “The selection of China Telecom, which follows the almost immediate disqualification of the two other bidders, hints at the government’s bias towards Chinese involvement in the telecoms sector, and is a clear sign of Duterte’s warming posture towards China.”  It was more than a bias, it was a setup. [See Has the Choice for the Third Telco Player Been Rigged? Will a National Social Credit System be the Next Telecom Agenda? (November 11, 2018)]

As the web of political control expands over the economic sphere, the distribution of economic opportunities would become more politicized at the expense of the marketplace.

Even the allocation of banking loans has become slanted towards industries favored or controlled by the NG.

Figure 3

Bank loans to the politically favored or controlled sectors grew robustly as these were the principal contributors to the improvement in bank lending in October, namely construction (39.08% in October, 37.04% in September), public administration and defense (28.19% and 27.52%), education (25.95% and 23.86%) and financial intermediation (32.01% and 31.01%). Only loan growth to the transport industry fell 17.73% and 22.03%.

Of course, there will always be a tradeoff. The opportunity costs of rewarding political sectors come at the expense of the consumers. Bank loan growth to the retail sector slipped to +19.91% in October from 22.71% in September and have now caught up with the sharp downturn in consumer loans +14.61% in October and 18.19% a month ago.

If the growth of cash in circulation (m1) collapsed in October (+8.92% from +11.4% a month ago) and where credit card spending slowed (+21.6% and +22.2%), how did consumers finance their spending? Salary loans continued to contract for four straight months!

The consumer economy paid the price of redistributing benefits to the political and politically affiliated sectors.

So what should happen to the frenetic race-to-build supply for the consumers?

The Carrying Costs of Spend, Spend and Spend Elixir: Accelerating Credit and Sovereign Risk and Peso Devaluation

However, there is no such thing as a free lunch.

The political spending elixirs that should serve as the nation's economic deliverance requires funding.  

Thus, spend, spend and spend has been supported by a mixture of debt and the BSP’s monetization.

Figure 4

An update of the public debt data has yet to be published by the Bureau of Treasury.

Nevertheless, debt servicing of public debt swelled to Php 649.72 billion running at a rate to reach possibly the record high of Php 854.374 billion in 2006. The share of debt servicing to revenues jumped from a record low of 19.83% in the year 2017 to 27.55% in the 10-months of 2018.

With the burgeoning amount of debt supported by increasing interest rates, debt servicing can be expected to keep moving in pace with the record growth of deficits. One of the carrying cost to the economic deliverance from spend, spend and spend elixir would be the deepening leveraging of the taxpayer’s balance sheet and its attendant risks.

For as long as there will be access to credit or someone’s savings or income (via tax), the spending panacea can go on.

Naturally, the NG can’t use an all debt financing because it would siphon away liquidity in the private sector. If the private sector, the principal source of funding gets drained, from where will they get funding? That’s the reason why central banks exist.

To leave some crumbs to the private sector, the BSP assumes the other role of providing finance to the intensifying public sector spending.

From the BSP’s October domestic liquidity report: “Net claims on the central government grew by 11.3 percent in October, broadly steady from 11.4 percent (revised) in the previous month.”

The BSP allotted Php 17.09 billion in October for a 10-month aggregate of Php 207 billion or about 47.25% of the total deficit during the said period, the second largest amount of monetization by the BSP since 2015. The BSP launched its version of Quantitative Easing in 2015.

So the other carrying cost to the economic deliverance from spend, spend and spend elixir would be to inflate the system at which comes at the sacrifice of the peso, or the citizen’s purchasing power

The Contortion of Keynesian Economics: Bulging Deficit-to-GDP Ratio in Good Times; With Emergency Policies in Place, What’s Left When The Tide Runs Out?

The 10-month record deficit of Php 483.1 billion is just Php 40.5 billion shy from the NG's target of Php 523.6 billion

Christmas spending such as the published Php 25k bonus to government employees and other yearend earmarks can easily push such deficit beyond the official annual target.

Revenue conditions will play a critical role. If collections underperform in the face of programmed increases in expenditures, deficits will be pushed further away from the target. That said, how the NG finances this will be projected into the interest rates, the CPI, debt levels, the economy, and earnings.

So far, in the thrust to finance the record NG deficit and to clamp down on the CPI, the BSP has been tightening liquidity in the system directed at the private sector. The sharp fall of M3 and consumer credit demonstrates such transfer as shown above.

While tax collections have held ground in October, the effect of such tightening may lag.

In the last twenty years, deficit-to-NGDP ratios of over 3% occurred during downturns in revenues as an outcome of economic slowdown.

And public expenditures were ramped up in only times of economic stress, such as the Economic Resiliency Plan (ERP) in 2009, put in place as a stabilizing force against the Great Recession. Part of the ERP was the transitory Php 330 billion fiscal stimulus (4.1% of GDP)

A gradual withdrawal of fiscal stimulus segued as the economy gained momentum.

As I have been saying here, this time is different.

Fiscal stimulus used against adverse external influences has become the principal development model used to attain economic growth. The former, known as Keynesian economics, has been reinvented.

At the end of 2018, fiscal deficit should breach past 3% of GDP target even with the headline GDP hovering at 6% and above. (chart shows 1986-2017 only). Again, traditionally, 3% deficit to NGDP ratio coincided with falling real GDP. Not today.

The Philippine economy has been surviving on emergency measures via monetary stimulus (record QE, record low interest rates) and unprecedented fiscal stimulus.

Diminishing returns from these measures have become apparent even when no downturn or crisis has yet transpired. The peso has fallen, market rates, as well as, policy rates have increased and debt continues to mount.

Remember this? (FSCC’s FSR 2017)

While there is no definitive evidence of a looming crisis, it is also clear that shocks that have caused dislocations of crisis proportions have come as a surprise.

What policy tools would be left for our policymakers to use, should a genuine shock (whether of internal or external origin) occur?

Rising Risks of a Fiscal Crisis: Record Public Spending Share to GDP! BIR Revenue Plunged 8% in September! Public Debt Servicing Costs Rockets!

But if the government invests funds unsuccessfully and no surplus results, or if it spends the money for current expenditure, the capital borrowed shrinks or disappear entirely, and no source is opened from which interest and principal could be paid. Then taxing the people is the only method available for complying with the articles of the credit contract. In asking taxes for such payments the government makes the citizens answerable for money squandered in the past. The taxes paid are not compensated by any present service rendered by the government's apparatus. The government pays interest on capital which has been consumed and no longer exists—Ludwig von Mises

In this issue:

Rising Risks of a Fiscal Crisis: Record Public Spending Share to GDP! BIR Revenue Plunged 8% in September! Public Debt Servicing Costs Rockets!

-Signs of the Neo-Socialist State: Record Public Spending Share to GDP!

-Rehabilitated Boracay: A Prison Resort or An Enclave of Cronies and Politicians?

-Examples of The Fascist Model of Socialism: Boracay, Telco, TNVS and Others

-The Story of 9-Month Fiscal Deficit: Rapid Pace of Public Spending Growth as Revenues Slow

-Liquidity Crunch Hits Demand? BIR Revenue Plunged 8% in September! Total Revenues Grew a Paltry 1.13%

-Public Expenditures Decelerate in September, May Add to the Liquidity and Demand Woes

-TRAIN Boomerangs as VAT Misses Targets By a Mile! DOF: Inflate Philippine Debt Away!

-Surging Public Domestic and FX Debt Intended To Finance Twin Deficits: Fiscal and BOP Imbalances!

-Rocketing Costs of Debt Servicing! The IMF’s Blueprint on Predicting Fiscal Crises

Rising Risks of a Fiscal Crisis: Record Public Spending Share to GDP! BIR Revenue Plunged 8% in September! Public Debt Servicing Costs Rockets!

Signs of the Neo-Socialist State: Record Public Spending Share to GDP!

The Neo-socialist state. That is the elected direction the Philippine government has undertaken for its development model.

 

Figure  1

No better proof of the current state of our political economy than this data.

The ratio of public expenditure to GDP has spiked to its highest level since 1998! (the data is limited to only 1998)

In the nine months of 2018, this ratio, representing the National Government’s (NG) DIRECT control of the economy, has broken the 20% threshold!

Since the private sector has also been mobilized to finance and operate some of the public projects, they also contribute to the rapidly expanding NG's control of the nation's resources.

That said, 20% is a CONSERVATIVE estimate of the NG’s actual command of the economy!

And there’s more.

Public outlays are supposed to represent actual data. On the other hand, GDP signifies an econometric constructed model of the economy founded on surveys as inputs. 

In other words, a comparison of facts against an estimate could distort the actual conditions.

First, an overestimation of the GDP would translate to the underestimation of the NG’s command of the nation’s economic activities.

Next, budgets are mostly fixed, revenues aren’t. Or, since public expenditures are programmed, irrespective of economic performance, a lower GDP would magnify the NG's share of the economy. 

Third, the inflation tax, or the actual loss in the purchasing power of an individual, is hidden from statistics.  In doing so, the ratio understates the government’s share of the economy.

Ergo, with the NG’s thrust to control the economy DIRECTLY, through deficit spending, and INDIRECTLY, through the inflation tax, political mandates, licensing, subsidies and regulation, statistics haven’t captured fully its contribution accurately.

And costs are not benefits.

Revenues of the government emanate from taxation.

Men live by production, wrote the esteemed journalist Frank Chodorov, but the State lives by appropriation

The appropriation of the means of production of property owners and the diversion of resources to the government to spend on its volition is socialism.

As the government commandeers a larger share of the economy, the private sector’s share shrinks.

And government expenditures translate to the substitution and transfer of the means of production for consumption, which entails capital consumption.

As the government expands at the expense of the private sector, capital will be reduced.

Lesser capital means reduced productivity growth that heightens economic and financial risks!

Rehabilitated Boracay: A Prison Resort or An Enclave of Cronies and Politicians?

And that would signify the statistical side of the economy.

As said above, the path to socialism has hardly captured by statistics.

A great example would be Boracay which had its soft opening this week.

The government will not only limit and control demand and supply, but it would also restrict social activities, people mobility (entrance and exit) and remarkably even control the number of population in the island!

From Philstar: The BIATF will also limit the number of tourists allowed on the island on any given day at only 19,215 guests, based on the carrying capacity recommendation of the Department of Environment and Natural Resources (DENR). According to the carrying capacity study, the island and its swimming areas can only support 55,757 people per day – broken down into 36,542 residents and workers and only 19,215 tourists.

And tap cards and bracelets have been proposed by the government to control the flux people!

So if the island’s quota is 55,757 people, to allow more tourists means to diminish the population! And to achieve this, the government picks who is ‘in’ and who is ‘out’. And unaccredited establishments are the possible first candidates of the Boracay purge. By political exclusion, these companies will be forced to close shop, thereby inciting such stakeholders (employers and employees) to move elsewhere!

And guess who will be the privileged personalities who would acquire residency in such exclusive politically carved enclave???

As I wrote last April, “Boracay will now transform into a playground for the rich, the politically connected and the political class.” See Institutionalizing A Neo-Socialist State: Demand Controls on the War on Boracay and Price Controls on the War on TNVSApril 22, 2018

I wondered if I had been reading articles about Boracay or a prison compound masquerading as an island resort.

And guess who are the beneficiaries of Boracay’s contribution to the NG’s record deficit spending via rehabilitation?

From the Inquirer: “The DENR had already partnered with several of the country’s top conglomerates—the Lucio Tan Group, San Miguel Corp., the Gokongwei Group, the Aboitiz Group—and the Lopez-controlled Energy Development Corp. to rehabilitate the wetlands and turn them into ecotourism sites.”

One of them made amends with the leadership by paying Php 6 billion in supposed back taxes last year. As such, aside from the rehab partnership, the tycoon's firm has been bestowed further with the political privilege, having been awarded with a license to operate an inter-island ferry services to Boracay.

So the principal recipients of the largesse of subsidies financed by TRAIN and inflation will be the elites!

The average Juan, Pedro, and Maria have been made to bear the burden of the erosion of the standards of living just to accommodate such invisible transfers to the elites and to the political leadership!

Such transfers showcase the deepening rent-seeking nature of the neo-socialist economy.

Incredible!

And here’s more.

The elites have been mobilized to partake of the economic opportunities provided by the NG at the expense of the markets or the consumers.

In doing so, the government now controls the resources of the elites in exchange for carrots from political privileges!

So what happens now to the race to build supply?!

Examples of The Fascist Model of Socialism: Boracay, Telco, TNVS and Others

Whether it is about Telecom franchise (Villar) or infrastructure (Dennis Uy), Mr. Duterte has the elites on his palms.

And to finance such political privileges, a favorite neophyte elite has, reportedly, been guzzling debt with such intensity (200% debt increase in one year!). 

The recent sprint in debt acquisition by cronies reminds me of the ill-fated empire of Brazil’s oil and mining magnate Eike Batista. $35 billion vanished in 2 years, and Mr. Batista's net worth turned negative! To rub salt to the wound, the erstwhile billionaire has even been serving a jail sentence for corruption!

Furthermore, competition is amazingly seen on a different lens by the National Government (NG) and the mainstream. Instead of open competition to provide consumers with the best services at most affordable prices, the bidding process for the third telco participant represents a competition designed to GRATIFY the whims of the government!

The byzantine obstacles via the “highest committed level of service (HCLoS)” imposed ensures not only of high costs and elevated risks for the third player, but also the challenge to cut through the thicket of regulations! A crony, who dabbled earlier with the industry, said that money is the key to the success of the third player. Oddly, after acquiring mountains of debt, he sold out in 2016. Duh!

The same “competition” template applies to the Transport Network Vehicles Services (TNVS) industry. Because supply isrestricted, participants are limited. Price controls affect demand too. Various interventions affect the industry’s operations andpotential competition. Excessive regulations and the virtual control have stifled the industry’s growth potentials and actual output! And shortages have been a natural consequence.

Fascism is the contemporaneous model of socialism embraced by the Philippine leadership. 

The nuances of traditional socialism with its fascist version as explained by Sheldon Richman, a research fellow at the Independent Institute, at the Library of Economics and Liberty. (bold mine)

As an economic system, fascism is socialism with a capitalist veneer…Where socialism sought totalitarian control of a society’s economic processes through direct state operation of the means of production, fascism sought that control indirectly, through domination of nominally private owners. Where socialism nationalized property explicitly, fascism did so implicitly, by requiring owners to use their property in the “national interest”—that is, as the autocratic authority conceived it. (Nevertheless, a few industries were operated by the state.) Where socialism abolished all market relations outright, fascism left the appearance of market relations while planning all economic activities. Where socialism abolished money and prices, fascism controlled the monetary system and set all prices and wages politically. In doing all this, fascism denatured the marketplace.

It has been bad enough for a credit bubble to have taken place, but even worse is this credit-financed government bubble that has been denaturing the marketplace.

And a remarkable character of socialism is its inherent bias in favor of the politically connected and the moneyed elites as against the average citizenry and the entrepreneurs. The experiences of Boracay, Telco, and the TNVS attest to this.

And the unintended consequences from the intensifying political socialization process will emerge in the various aspects of the Philippine political economy.

The Story of 9-Month Fiscal Deficit: Rapid Pace of Public Spending Growth as Revenues Slow

Because socialism is all about redistribution through central planning by a centralized state, it thrives only if the host has enough essence to feed the parasites.

As noted last week, the 9-month Balance of Payment deficit signifies a symptom of a reverse Robin Hood, which transfers resources and finances from the Main Street to the Political class.

The transmission mechanism for this is through the accelerating credit expansion which finances demand, borrowed from the future, on the politicized segments of the economy. [see 9-Month Balance of Payment Deficit Soars to Record! Incipient Signs of Capital Flight? As Expected, Peso Rallied; Price Controls Magnifies Inflation! October 22, 2018]

So to finance investments (mostly public through build, build and build), the public and the private sector went into a borrowing spree in foreign exchange (of course)!!!!

The September report on the National Government’s Fiscal Conditions, Outstanding Debt and Debt Servicing by the Bureau of Treasury has validated this

First, the record breakthrough of the 9-month Fiscal Deficit

From the Inquirer: “Faster-than-programmed spending on public goods and services widened the national government’s budget deficit to P378.2 billion as of September. The end-September fiscal deficit was 78-percent bigger than the P213.1 billion posted in the first nine months of last year, the latest Bureau of the Treasury data released Monday showed.”

 

Figure 2

To sum up the 9-month fiscal balance picture, it has been a product of accelerating public expenditures in the face of faltering tax collections! (see figure 2: upper pane)

Yes, you read me right: tax collections have wobbled in the last two months!

Before that the record deficit.

Not only has 2018’s 9-month record deficit of Php 378.234 billion surpassed last year’s level, most importantly, it also zoomed beyond the 2016’s annual record deficit of Php 353.422 billion by Php 24.812 billion or by 7.02% with a quarter to go. (see figure 2: lower pane)

At the current average monthly rate of Php 42.03 billion, the year-end deficit would reach 96.3% or Php 504.312 billion of the annual target of Php 523.7 billion.

Either the capital market or the BSP would finance the potential Php 126.08 billion in the budget gap in the 4Q. 

And September’s deficit of Php 96.25 billion signifies the largest since at least 2008!

Liquidity Crunch Hits Demand? BIR Revenue Plunged 8% in September! Total Revenues Grew a Paltry 1.13%

Next, emaciating revenues

On the revenue side, while the 9-month growth of 17.21% produced the highest since at least 2008, 3Q growth registered only 12.13% down from 14.54% a year ago.

 

Figure 3

Total revenue (tax and nontax collections) growth plunged to 1.13% in September from 11.49% in August and 24.21% in July.

Bureau of Internal Revenue collections cratered -7.68% in September from +7.83% in August and +18.77% in July. (Figure 3)

The Inquirer explained: “The Bureau of Internal Revenue’s tax take last September declined by 8 percent year-on-year to P130.6 billion, which the Treasury blamed on the “high-base effect of the P17.6-billion partial settlement from Mighty Corp. collected last year.”

The September’s crash was worse than the Dec 2015’s -7.27% and was surpassed only by the post-Great Recession effects in 2009!

Remember, it was in the late 3Q 2015 were the BSP initiated its QE.

Bureau of Customs collections decelerated +26.86% in September from +35.84% in August and +49.01% in July.

It can hardly be about the base effects because collections of the Bureau of Customs echoed the material slowdown in the BIR.

Non Tax collections improved +11.63% in September from -5.07% in August and +20.43% in July.

BIR had the largest share of September’s overall revenue at 65%, the Bureau of Customs at 25% and Non-Tax Segment at 9%.

Rather than the base effects, a more significant factor may have been of influence. And that is liquidity.

Figure 4

The plummeting M3 rate in the reflection of slowing bank credit expansion and financial problems within the banking industry has dragged the NG revenues down. (figure 4)

The tightening process, which has affected the financial system, as expressed by raging rates of domestic treasuries across the curve extrapolates to lesser money in circulation. Reduced liquidity implies diminished transactions. Thus, bank loans and M3 have weighed on BIR and BoC collections. For this reason, the downturn in BIR and BoC collections may have been about the conditions of the real economy!

And real events may be supporting the growing slack in demand. From the GMA/MSN: “Consumers were put off by their own expectations of higher prices that they decided to steer clear of vegetables, the Department of Trade and Industry (DTI) said Wednesday. As a result, vegetable prices went down following the law of supply and demand.”

Public Expenditures Decelerate in September, May Add to the Liquidity and Demand Woes

Third, expenditures slowdown.

The growth rate of the expenditure side has also moderated. It decelerated +26.86% in September from +28.6% in August and +33.86% in July.

The deceleration in public expenditures may have contributed to the sharp decline in M3, and consequently, to NG revenues.

The Inquirer reported that “build, build and build” boomed by 70.5% in August but was lower compared to July in the context of the amount spent.

If public spending has signified as the only force keeping up the statistical economy (GDP), its slowdown will entail an underperformance in the GDP. 

Has the mainstream considered this?

And while the budget deficit may be within in the proximity of the NG’s target, revenue goals have hardly been the reason for this. In contrast, the budget gap climbed higher because of the shortfall in the revenue goals. The 9-month revenue to adjusted GDP was at 3.06%.

And should the revenue expectations continue to underperform in the face of the continuing aggressive push for public spending, the budget gap may soar far beyond the National Government’s target.!

That said, the NG is playing with fires of a fiscal crisis. Play with fire and the chances of getting burned increases.

TRAIN Boomerangs as VAT Misses Targets By a Mile! DOF: Inflate Philippine Debt Away!

Fourth, snowballing unintended consequences 

And unintended consequences continue to hound the NG.

Proof?

From the Inquirer (October 23): “The net revenue gained during the first eight months of implementation of the Tax Reform for Acceleration and Inclusion (TRAIN) Act reached only P10.6 billion, below target by 74.1 percent, as the take from sugary drinks, coal, oil products, as well as value-added tax (VAT) fell short. Department of Finance (DOF) documents showed that the additional revenues collected by the bureaus of Customs (BOC) and Internal Revenue (BIR) from January to August were lower than the programmed P41 billion supposed to come from the TRAIN Law’s new or higher taxes on consumption. (bold mine)

To repeat “below target by 74.1 percent”. Hasn’t the DOF heard of the law of demand applied to taxes, “If you tax something, you get less of it”?  Or do they think that they can control, like the massive cheatings in the PSEi, the pricing system without repercussions?

And here’s more.

In response to the popular clamor from a public beleaguered with raging street prices, the DoF proposed the postponement of the implementation of the second round of excise tax increases scheduled in 2009 for a quarter

Will the NG reduce its spending concomitantly to adjust with a lower revenue intake? Or, will the capital markets remain accommodating to the NG to give them hope?  Or perhaps, could the NG be counting on the BSP to do the rest of the financing legwork?

And here the DoF tacitly and stunningly admits of the use of inflation to fund its deficit spending!

From the Manila Bulletin: “The projected revenue loss from the suspended increase in fuel tax could be reduced if the US dollar further appreciates against the peso next year, although consumers will still have to brace themselves in 2020 as the tax hike could double following the suspension.”

Translation: Inflate the Philippine debt away!

Perhaps, an additional clue to the continued use of inflation to finance record deficit spending. In attributing high oil prices, the leadership admitted to being “helpless in addressing inflation”.  Is he being advised to use oil as a convenient scapegoat? 

And with price controls in place for rice prices starting October 27, the supply side influence for high price levels have commenced.

And adding to the supply side fuel for higher street prices would be the Palace’s hope for “an acceptable minimum wage ruling’.

Truly astounding developments! Stagflation is just a corner away!

So while demand may be slowing, the distortions from the supply side interventions are likely to keep prices elevated.

And if the record-setting pace of deficit spending is sustained, the question is how will this be financed?

Surging Public Domestic and FX Debt Intended To Finance Twin Deficits: Fiscal and BOP Imbalances!

Fifth, soaring debt levels

So how has the record 9-month Php 378.23 billion budget gap been financed?

The Bureau of Treasury’s data on Government Debt sheds light to it.

 

Figure 5

Domestic debt grew by Php 146.514 billion in the 9-months of 2018, constituting about 38.7% of the fiscal gap over the same period. The BSP could have financed the balance. As of August, the BSP’s 8-month net claims on Central Government totaled Php 145 billion. (figure 5 upper window)

Public domestic debt grew by 9.53% or Php 14.85 billion in September. Meanwhile, foreign exchange debt jumped by 14.03% or by Php 41.07 billion.

Foreign exchange liabilities expanded by Php 360.832 billion in the three quarters of the year.  About half of this increase came from the strengthening of the USD. Additional borrowing by the government had been intended to fund the Balance of Payment BOP USD gap and to cushion the peso’s fall. (figure 5 upper window)

These numbers affirm my projections last week.

So to finance investments (mostly public through build, build and build), the public and the private sector went into a borrowing spree in foreign exchange (of course)!!!!

Total debt (domestic and foreign) grew by 11.11% to Php 7.15 trillion in September or 43.54% of 1H annualized GDP.

The banking system issued Php 606.3 billion in loans to the public in the 8-months of the year. September’s domestic debt would account for 24.16% share of bank credit expansion.

The banking system offset their credit expansion by soliciting funds from the public. Essentially, a significant segment of liquidity infusion had been neutralized by the government and the banking system’s absorption of them.

See now why rates have been rising???

If budget deficits would swell by Php 126 billion in the 4Q to Php 504 billion in 2018, and if the banking system will compound on these through more bond and LTNCD offerings; would liquidity in the system not be further strained? 

The loanable funds market has yet to feel the effects of the 100 bps rate hikes in August and September. What if demand for loanable funds falls in response to higher rates, will these not escalate the liquidity drought in the system?

A big factor in the economy going forward will be the supply of debt or demand for savings. That’s because, aside from inflation, these will influence interest rates.

Meanwhile, the growing forex exchange liabilities represent another crucial factor in the public’s debt profile.

To finance the BoP deficit, the NG and the BSP has been expanding its US dollar shorts exposure that needlessly raises the nation’s currency and credit risks

Rocketing Costs of Debt Servicing! The IMF’s Blueprint on Predicting Fiscal Crises

Debt servicing has rapidly risen in the face of higher rates and more issuance of debt.

In the 9-months of 2018, debt servicing (interest and amortization) has reached Php 620 billion outpacing the annual debt servicing of 2013 to 2017. At the current rate, debt servicing may close the year with Php 827.4 billion shy of the 2006 record of Php 854.374 billion. What if the record will be broken? (see figure 4)

The ratio of debt servicing to NG revenues has been rising fast. It has jumped to 29.4% in 9-months to reach 2013 annual levels.

If the capital markets will be relied on to finance the budget deficit growing at a breakneck speed, then the trajectory is for the ratio of debt servicing to revenues to grow faster.

If revenues slow in response to a liquidity crunch, this ratio would rise by even more!

In the realization of the necessity to raise funding for the government, the BSP has eased requirements for the investing in the UITF.

From the BusinessWorld: THE CENTRAL BANK is expanding opportunities under unit investment trust funds (UITFs) by allowing placements in government-issued debt papers. Bangko Sentral ng Pilipinas (BSP) Deputy Governor Chuchi G. Fonacier said the Monetary Board has approved more options for UITFs to further entice investors with low risktolerance. “In order to maximize participation of the trust industry in the said issuance of the BTr (Bureau of the Treasury), the Bangko Sentral has expanded the allowable investments of conservative money market UITFs to include securities issued by the national government,” Ms. Fonacier told reporters.

As I’ve said earlier, the Duterte regime is playing with the fires of a fiscal crisis.

In a study, the IMF provides a blueprint of a Fiscal Crisis in progress….

While the findings do not necessarily imply causality, they reveal how policies and key economic variables evolve around these exceptional periods. First, we find that fiscal policy is procyclical, especially in AMs and EMs. Crises are preceded by loose fiscal policy, as expenditures grow above average. Once the crisis starts, countries tighten expenditure growth as economic conditions deteriorate. Second, economic growth tends to sharply decline at the onset of the crisis and, at least partially, there seems to be a permanent decline in GDP. AMs and EMs face the deepest contraction in growth and about half of them experience recessions. Thedecline in economic growth is particularly large when crises are triggered by high inflation. Third, public debt tends to rise and remain elevated during the first years of the crisis. An exception is when the crisis is identified by credit events that only involve official creditors. Fourth, fiscal crises are usually associated with both fiscal and external imbalances. We find that twin deficits usually deteriorate in the pre-crisis years. Finally, the data also shows that fiscal-financial twin crises experience a deeper decline in growth than stand-alone fiscal crises

While I am no fan of the IMF, because the ingredients of a fiscal crisis have been present in the current environment, it pays to listen: loose fiscal policy on expenditure growth, slowing economic growth, high inflation, rising public debt and external imbalances (BoP)   

*Kerstin Gerling, Paulo Medas, Tigran Poghosyan, Juan Farah-Yacoub, and Yizhi Xu, Fiscal Crises January 2017

As one can see, the pivot to a neo-socialist state doesn’t only come for free, it is booby-trapped with land mines!

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